Stan Druckenmiller (Duquesne Capital Management Founder) – CNBC Interview (Dec 2017)
Chapters
00:00:00 Economic Normalization and Inflation Targets
Normalization vs. Tightening: Druckenmiller believes the focus should be on normalization, not tightening, as the Fed raises rates. Normalization involves reestablishing a hurdle rate for investment, which has historically existed for 5,000 years.
Inflation Misconceptions: Druckenmiller challenges the idea that near-zero interest rates and deflation are scary or abnormal. He cites a study from the Bank of England showing that inflation has averaged 1.08% over the past 700 years, excluding the 70s and 80s.
2% Inflation Target Questioned: Druckenmiller believes the 2% inflation target is arbitrary and not always appropriate. He argues that during periods of rapid real growth, like the late 1800s and the 1950s, inflation was lower than 2%.
00:03:21 Distorted Market Signals and Misallocation of Resources in an Innovative Economy
Critique of the 2% Inflation Target: Stan Druckenmiller argues that the 2% inflation target is too rigid and does not account for different economic circumstances. He suggests that during periods of innovation and increased productivity, a lower inflation target or even deflation may be appropriate.
Distortions Caused by Low Interest Rates: Druckenmiller believes that keeping interest rates near zero or below zero has distorted market signals and led to a misallocation of resources. He uses Bitcoin, art, and other asset classes as examples of this distortion, as their prices have been driven up by investor demand.
Impact on Companies: The low interest rate environment has allowed companies, such as Steinhoff, to borrow excessive amounts of money and stay afloat despite financial problems. Druckenmiller argues that this hinders long-term economic growth by supporting zombie companies.
Bitcoin as a Currency: Druckenmiller dismisses the idea of Bitcoin as a medium of exchange due to its high volatility and impracticality for retail transactions. He acknowledges its value as a speculative asset but cautions against treating it as a long-term investment.
Macro Trading Performance: Despite strong stock market performance, Druckenmiller’s macro trades have struggled in 2017. He likens his experience to Seve Ballesteros’ famous four-putt at the 16th hole in Augusta, describing a series of missed opportunities. He attributes his losses to misjudging the strength of the U.S. dollar and making several poor trading decisions.
00:12:00 Central Bank Radicalism and Market Timing
Mistakes and Over-trading: Druckenmiller attributes his underperformance in 2017 to over-trading and being cold at the wrong time. He emphasizes the importance of allocating exposure appropriately, mentioning that over-allocating to fixed income relative to equities was a mistake.
Central Bank Impact: Druckenmiller believes that the current market performance cannot be solely attributed to earnings, as earnings have not been consistently strong in recent years. He argues that central bank actions, such as buying $1 trillion worth of bonds annually, have significantly influenced asset prices. The radical policies of central banks, including quantitative easing and negative interest rates, have created a TINA (there is no alternative) scenario, pushing investors towards financial assets.
Potential Market Shift: According to central bank schedules, there could be a significant shift in bond buying, with the current trillion-dollar annual rate potentially dropping to minus $600 billion. This transition would involve central banks selling bonds, potentially leading to a decrease in financial asset prices.
Timing and Market Indicators: Druckenmiller emphasizes the importance of timing in the markets and expresses uncertainty about when the impact of these changes will be felt. He notes that traditional market indicators like breadth remain positive, likely due to continued central bank buying. As central bank buying decreases and eventually turns negative, these indicators may begin to reflect the changing market dynamics.
00:15:03 Investment Strategies and Views of a Hedge Fund Manager
FANG Stocks: Stan Druckenmiller likes Facebook, Amazon, Netflix, and Alphabet (FANG) for the long term. He sees potential disruption in the economy and prefers to find opportunities on the other side rather than hedging.
IBM: Druckenmiller views IBM as a company that has been under-investing and buying back stock while competitors gain an advantage in cloud and AI.
Retail Shorting: He has been shorting retail throughout the year due to the overabundance of retail space in the United States compared to other countries.
Amazon: Druckenmiller loves Amazon and believes its valuation is attractive compared to traditional sales multiples. He sees Amazon’s under-earning as a strategy to invest in future growth.
Tencent: Druckenmiller admires Tencent’s position in payments, entertainment, cloud, and gaming. He sees similarities between Tencent and Amazon’s growth strategies through under-earning.
Tesla: Druckenmiller has not owned Tesla and shares a story about rejecting a short proposal because the analyst had never driven the car. He does not find the financial model and economic model of Tesla convincing for shorting.
Apple: Druckenmiller does not find Apple as exciting as other tech companies, as it is a hardware company and he does not see the same under-earning potential.
Workday: Druckenmiller likes Workday’s fit in the new economy and praises the CEO, Anil Boosray.
Tax Reform: Druckenmiller’s response to tax reform is nuanced, and he acknowledges that it is a complex issue.
00:21:17 Assessing the Impact of the Current Tax Reform Plan
Excitement for Deregulation and Tax Reform: Druckenmiller was initially optimistic about the prospects for deregulation and tax reform following the 2016 election. He saw the House program, “A Better Way,” as a potential solution to address the fundamental problem of over-consumption and under-investment in the United States.
Missed Opportunity: Druckenmiller viewed Secretary Mnuchin’s handling of tax reform as a missed opportunity. He felt that the final tax reform plan did not go far enough in addressing the fundamental issues facing the economy.
Helpful Aspects of the Tax Reform Plan: Druckenmiller acknowledged some positive aspects of the tax reform plan. He highlighted expensing, interest deductibility, and the broadening of the tax base as beneficial elements.
Personal Impact of the Tax Reform Plan: Druckenmiller personally will not receive a tax cut under the plan and expects a 600-point increase in his tax rate. The repeal of the estate tax, particularly in relation to large estates, is not viewed favorably by him.
Support for Territorial Tax System and Border Adjustment Tax: Druckenmiller expressed support for moving to a territorial tax system. He strongly advocated for the implementation of a border adjustment tax, which he considered an elegant solution to the problem of over-consumption and under-investment. The killing of the border adjustment tax due to lobbying efforts from retail companies was seen as a failure.
Tax Reform Impact on Stock Market: The expected tax cuts might not significantly impact the stock market since the market already reflects anticipated changes. Stock market performance is primarily influenced by central bank policy. Any positive impact on corporate earnings through tax cuts might be offset by corresponding adjustments in central bank policies.
Economic Effects in 2018: The tax plan could have a stimulative effect on the economy in 2018 and for a few years thereafter. Accelerated depreciation (expensing) regulations, if implemented before corporate tax cuts, could enhance capital spending and investment in 2018.
Concerns Regarding Fiscal Stimulus: Druckenmiller expresses doubt that the proposed tax plan qualifies as genuine tax reform due to its focus on fiscal stimulus rather than offsetting spending. He emphasizes the need to preserve fiscal resources for potential economic challenges in the future. He criticizes the increasing national debt with this tax plan, comparing it to historical trends from previous administrations.
Missed Opportunity for Entitlement Reform: Druckenmiller proposes that the fiscal stimulus from the tax plan should have been coupled with entitlement reform. He points out the urgency of addressing entitlement programs, particularly with the demographic trend of baby boomers reaching retirement age. The tax plan, in his view, exacerbates the problem by neglecting entitlement reform while increasing the national debt, jeopardizing the nation’s long-term financial health.
Opinions on Tax Reform: Unfavorable view of carried interest provision. Favors reforming Medicare and Social Security. Critical of tax increases for professionals in blue states to fund tax cuts for billionaires. Believes that companies buying through carried interest often strip assets and fire people, rather than increasing employment. Expresses outrage that politicians supporting carried interest tax cuts claim to seek loopholes and reforms.
Kevin Warsh as Fed Chair: Expresses mixed emotions about Warsh not being appointed as Fed Chair. Praises Warsh’s intelligence and forward-looking nature. Believes Warsh would have been an incredible Fed Chair. Emphasizes the need for reform in the Fed’s 2% target and the use of common sense in monetary policy-making.
Views on Fed Policy: Believes the Fed should take every opportunity to normalize interest rates. Critical of the Fed for not raising rates two or three years ago. Expresses concern about the explosion of corporate debt due to the Fed’s low-interest rate policies. Favors raising rates while the world economy is robust and to normalize the investment environment.
Abstract
Assessing Monetary Policy and Market Dynamics: Druckenmiller’s Perspective with Supplemental Updates
In a financial landscape marked by shifts in Federal Reserve policies and market dynamics, Stan Druckenmiller’s insights provide a critical lens for understanding the interplay between central banking decisions and market performance. This updated article delves into Druckenmiller’s critique of central bank policies, particularly the Federal Reserve’s interest rate strategy and its impact on the market. It also explores his views on Bitcoin, tax reform, and investment strategies, highlighting his concerns about market exuberance and potential asset bubbles. By aligning these insights with current monetary shifts and market trends, we can better comprehend the intricacies of today’s economic environment.
1. Federal Reserve’s Interest Rate Strategy
The Federal Reserve raised interest rates by a quarter point, aligning with market expectations. This shift, during the transition from Janet Yellen to Jerome Powell as Fed Chair, raises questions about the future of monetary policy. The market anticipates three to five rate hikes in 2018, signaling a potential return to policy normalization. Druckenmiller, emphasizing the need to focus on normalization rather than tightening, challenges the conventional view of inflation and monetary policy. Historically, inflation has averaged 1.08% over the past 700 years, excluding the 70s and 80s, questioning the zero-bound and deflationary risks perception. He advocates for abandoning the 2% inflation target, calling it a dogmatic approach initiated by academics, and highlights the impact of technological innovations like Amazon on Fed’s policy decisions.
Druckenmiller believes that as the Federal Reserve raises rates, the emphasis should be on normalization rather than tightening, which involves reestablishing a traditional hurdle rate for investment, a concept that has been around for 5,000 years. He challenges the notion that near-zero interest rates and deflation are scary or abnormal, citing a Bank of England study that shows inflation averaging 1.08% over the past 700 years, excluding the volatile 70s and 80s. Furthermore, Druckenmiller questions the appropriateness of the 2% inflation target, arguing that in periods of rapid real growth, such as the late 1800s and the 1950s, inflation was well below 2%.
2. Druckenmiller’s Critique of Central Bank Policy and Bitcoin
Druckenmiller criticizes central banks for their rigid adherence to a 2% inflation target, suggesting that a lower target might be more appropriate during times of innovation. He argues that the current low-interest-rate environment has led to market distortions and resource misallocation, using Bitcoin, art, and other asset classes as examples. This environment has also allowed companies like Steinhoff to borrow excessively, creating a landscape filled with ‘zombie’ companies. On Bitcoin, Druckenmiller dismisses it as a medium of exchange due to its volatility and impracticality for retail transactions, although acknowledging its value as a speculative asset.
In 2017, despite a strong stock market, Druckenmiller’s macro trades faced challenges. He compares his experience to Seve Ballesteros’ famous four-putt at the 16th hole in Augusta, noting missed opportunities and attributing his losses to misjudging the strength of the U.S. dollar and several poor trading decisions.
3. Investment Strategies and Market Dynamics
Druckenmiller’s investment strategies reveal a bullish stance on FANG stocks and a nuanced approach to short positions, which he views as independent investments rather than hedges. He appreciates the diverse business portfolios of companies like Amazon and Tencent but is skeptical of Tesla’s financial model. Druckenmiller also provides a complex view on tax reform, recognizing its potential economic benefits despite personal opposition to some aspects.
Druckenmiller attributes his underperformance in 2017 to over-trading and bad timing. He emphasizes the importance of appropriate exposure allocation, admitting that over-allocating to fixed income relative to equities was a mistake. He also believes that central bank actions, such as buying $1 trillion worth of bonds annually, have significantly influenced asset prices and created a scenario where investors feel there is no alternative but to invest in financial assets. He foresees a potential shift in the market as central bank bond buying might reduce significantly, which could lead to a decrease in financial asset prices. Druckenmiller highlights the importance of timing in markets and remains cautious about when the impacts of these shifts will be felt.
4. Tax Reform and Its Implications
Druckenmiller’s perspective on tax reform is multifaceted. Initially optimistic about deregulation and tax reform, he saw potential in the House program
, “A Better Way,” to address the fundamental issues of over-consumption and under-investment in the U.S. However, he viewed Secretary Mnuchin’s handling of the tax reform as a missed opportunity, feeling that the final plan did not sufficiently address key economic issues. Druckenmiller did acknowledge some positive aspects of the tax reform plan, such as expensing, interest deductibility, and a broader tax base. Despite not receiving a personal tax cut and disapproving of the repeal of the estate tax, he supported moving to a territorial tax system and implementing a border adjustment tax, which he saw as an elegant solution to current economic problems.
The impact of tax reform on the stock market is complex, as Druckenmiller notes that while tax cuts might boost corporate earnings, this might be offset by changes in central bank policies. He anticipates that the tax plan could stimulate the economy in 2018 and beyond, especially if accelerated depreciation regulations precede corporate tax cuts. However, he expresses concern about the focus on fiscal stimulus in the tax plan, emphasizing the need to preserve fiscal resources for future challenges and criticizing the increase in national debt. He also laments the missed opportunity for entitlement reform, crucial given the demographic trend of baby boomers reaching retirement age, and the exacerbation of national debt issues.
Market Dynamics and Future Outlook
In conclusion, Druckenmiller’s insights offer a profound understanding of the interplay between monetary policies, market dynamics, and investment strategies. His critique of central bank policies, views on technological innovation’s impact on the economy, and investment strategies provide a comprehensive overview of current financial trends. As the market evolves in response to these factors, Druckenmiller’s perspectives serve as a valuable guide for navigating the complexities of today’s economic environment.
Supplemental Update:
In an update to his views on tax reform, Druckenmiller expresses an unfavorable view of the carried interest provision and criticizes tax increases for professionals in blue states to fund tax cuts for billionaires. He is critical of companies buying through carried interest, often leading to asset stripping and job losses, and is outraged by politicians who support these tax cuts while claiming to seek loopholes and reforms.
Regarding the Federal Reserve, Druckenmiller had mixed emotions about Kevin Warsh not being appointed as Fed Chair, praising Warsh’s intelligence and vision. He emphasizes the need for reform in the Fed’s 2% target and advocates for common sense in monetary policy-making. Druckenmiller believes the Fed should have seized every opportunity to normalize interest rates and criticizes it for not raising rates earlier, expressing concern about the explosion of corporate debt due to low-interest policies. He favors raising rates while the global economy is robust to normalize the investment environment.
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